Insolvency: Exercise of discretion by Court to refuse an administration order

7th August, 2017

Background

The relevant provisions relating to the appointment of administrators are Schedule B1 of the Insolvency Act 1986. In order for an administration order to be made there are two preconditions specified in paragraph 11 of Schedule B1 which must be satisfied. The court must, firstly, be satisfied, on a balance of probabilities, that the company is, or is likely to become, unable to pay its debts. Either balance sheet insolvency or cash flow insolvency will suffice for the purpose of this requirement. Secondly, the court must also be satisfied that an administration order is reasonably likely to achieve the purpose of administration.

The purpose of administration is found in paragraph 3(1) of Schedule B1, which requires an administrator to perform his functions with the objective of (a) rescuing the company as a going concern, or (b) achieving a better result for the company's creditors as a whole that would be likely if the company were wound up (without first being in administration), or (c) realising property in order to make a distribution to one or more secured or preferential creditors.

The test for the fulfilment of each of the conditions is different. For inability to pay debts (insolvency) it is “more probable than not”, whereas for achievement of purpose it is a “real prospect”. See Re AA Mutual International Insurance Co Ltd [2005] 2 BCLC 8.

If the two preconditions are satisfied, the court retains a discretion, pursuant to 13(1) of Schedule B1, as to whether to make an administration order or not.

Key facts

The two companies for which administration orders were sought by the Applicants were Oak Property Partners Ltd (“Property”), which is the owner of a hotel in Hitchin, Hertfordshire, and Oak Forest Partnership Ltd (“Forest”), which is the owner of a hotel in Hever, Kent. Property and Forest are collectively referred to as “the Companies”.

The Companies were the freehold owners of the two hotels, with the business model of the Companies being the selling of individual hotel rooms and common parts to lessees on long leases. The Companies were not hotel operators and, effectively, carried on business as property developers.

The Applicants represented a number of room owners who had acquired leases of individual hotel rooms in both hotels. These leases entitled the room owners to a repurchase (buy-back) of the lease from the relevant company, being either Property in relation to Hitchin or Forest in relation to Hever. HHJ Purle QC accepted that the investors in both hotel rooms were given “extravagant promises of a guaranteed return which appear to have been more than optimistic and possibly reckless or wantonly misleading”.

In relation to the Hitchin hotel, a number of room owners gave notice to Property exercising their right to have the leases repurchased by Property. These buy-backs would come into effect within the next two years. In relation to the Hever hotel owned by Forest, a number of room owners gave buy-back notices to Forest which were due to come into effect starting in October 2016.

Judgment

HHJ Purle QC found that both of the Companies either were or were likely to become unable to pay their debts.

In relation to Property, HHJ Purle QC found that whilst the company was balance sheet solvent, this was dependent upon the recoverability of a very large debt from a company called White Linen Hotels and Resorts Ltd (“White Linen”), which was subject to a creditor’s voluntary arrangement (“CVA”). HHJ Purle QC found that the recoverability of the debt from White Linen was doubtful given that Property was a deferred creditor in the CVA. HHJ Purle QC also took into account the fact that there were a large number of repurchases that would take effect in 2018. Projections were prepared by Property, which HHJ Purle QC found to be “highly optimistic”, which depended on re-sales being achieved almost immediately after the buy-back by Property.

HHJ Purle QC noted that there was some evidence that cash may become available, although he found that the evidence produced by Property in this regard was shaky. HHJ Purle QC also considered that the 5% rate of return assumed in the hotel room valuations was optimistic and, in fact, exceeded the returns achieved thus far by Property.

At paragraph 21 of his judgment, HHJ Purle QC held that “…I cannot be confident that Property will overcome its present difficulties and on a balance of probabilities, even on a cash flow basis, I conclude that Property is likely at least to become unable to pay its debts in the future. Nonetheless it is, so it would appear, paying its debts currently, as they fall due and I cannot assume that there is no possibility of its recovery. I am sceptical about that but my scepticism must not be taken to be a statement of certainty, it is one of likelihood or probability and is an assessment of the future position not the present”.

HHJ Purle QC then considered whether an administration order in relation to Property was likely to achieve the purpose of administration. HHJ Purle QC accepted that rescue as a going concern was not a viable alternative and, further, that administration would achieve a better result for creditors than winding up. HHJ Purle QC held that winding up was not the only option and that a further option would be to give Property the opportunity to bring the business round.

HHJ Purle QC accepted that this depended on future events, such as for example a possible property boom, and the fact that he may turn out to be wrong on this point, stating at paragraph 22 of his judgment that “..That is for the future and, as the projections showing repurchases in the case of Property only start in two years' time, there is much to be said for waiting and seeing how events turn out”.

HHJ Purle QC also considered issues raised by the Applicants considering the unsavoury matters concerning those associated with Property having been associated with a timeshare fraud and the fact that the shareholders were a shadowy Nevis corporation. HHJ Purle QC held that he was unable to decide the case on the basis of those issues or that a desire to investigate was of itself a justification for an administration as that was not part of the purpose of administration.

Accordingly HHJ Purle QC held that although the two administration preconditions were technically satisfied, he would not at this stage exercise his discretion in favour of an administration order.

HHJ Purle QC held that Forest was in a similar position to Property, save that its repurchase obligations started in October 2016 (and to continue until August 2018) and, further, that it also had some management difficulties. These related to White Linen and the possibility that it would be placed into liquidation.

HHJ Purle QC held at paragraph 32 of his judgment that “Once again, the ability of the company to deal with those repurchases is dependent upon optimistic projections which I am sceptical about, but I would not, as a matter of discretion in this case either, as things stand, appoint an administrator, but would give the company the opportunity to endeavour to see its way through its difficulties. Whilst therefore an administration would be better than a winding-up, the option of remaining out of any insolvency process has better prospects, for creditors as well as for Forest itself, ultimately”.

In relation to the allegations of fraud, HHJ Purle QC held at paragraph 23 of his judgment that he would not have reached the same conclusion if there was firm evidence of fraud as opposed to a suspicion of past fraud.

Conclusion

This case is useful reminder of the fact that the court retains a discretion not to make administration orders notwithstanding that the two preconditions for an administration order were satisfied.

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